2.2.3 - Investment Flashcards
Define Investment
The addition of capital stock (e.g. machinery, offices, etc.) to the economy
Distinction between saving and investment
. In everyday language, saving and investment can be used interchangeably, but this is not true in economics
. Investment ONLY takes place if real products are created
Example :
.putting money into a bank account would be saving; a bank buying a computer would be an investment
. buying shares would be saving; buying machinery would be an investment
Name and explain two types of investment
. Gross Investment - The addition to capital stock, both to replace the existing capital stock and the creation of additional capital
. Net Investment - Gross investment minus depreciation
If gross investment is higher than depreciation, then net investment will be positive. This means that businesses will have a higher productive capacity and can meet rising demand in the future.
Define depreciation (of capital stock)
the value of capital stock has been used up or worn out and loses value
Name Six influences of investment
. the rates of economic growth
. business expectations and confidence (Keynes and ‘animal spirits)
. demand for exports
. interest rates
. access to credit
. the influence of government and regulations
Explain rate of interest
. A cut in the interest rates will reduce the cost of borrowing for firms and reduce the opportunity cost of borrowing. The lower the interest, the higher the profit made.This increases the marginal propensity to invest, which increases investment, increasing AD from AD1 to AD2.
. Additionally some investment is financed by retained profit (savings not distributed to shareholders but instead kept). The higher the rate of interest, the more likely that the firms save the money rather than investing into capital. This means the marginal propensity to invest falls and AD contracts from AD1 to AD2.
Explain influence of government and regulations
. By cutting tax on profits (corporation tax), the rate of return increase, which increases profits. This increases the marginal propensity to invest, increasing investment from firms, which shifts AD from AD1 to AD2.
. Increased regulations discourages investment due to increased costs for firms, which reduces profit, resulting in a decreased marginal propensity to invest.
Explain access to credit
. Some investment is finance by borrowing
. After the 2008 financial crisis, it became harder to get access to loans due to fear of firms not being able to pay back the money
. If banks are unwilling to lend, firms find it harder to access credit so it either more expensive (e.g. use of shark loans) or not possible to gain funds for investment. This decreases the marginal propensity to invest as it is harder to finance a project. This reducing investment in the economy, contracting AD.
Disadvantage of an increase in marginal propensity to consume and Advantage of an increase in marginal propensity to save (EVALUATION)
. If the marginal propensity to consume falls and marginal propensity to saves increases (e.g. due to higher interest rates) AD contracts from AD1 to AD2 in the short run
HOWEVER, if there are more savings in banks, it means that firms would be more willing to give out loans at a lower interest rate, which means more access to credit for firms. This increases the marginal propensity to invest, which increases investment shifting AD from AD1 to AD2, showing economic growth. This would be a long run effect of an increase in interest rates.
Explain demand for exports
. If there is a boom in the world economy, exports is likely to increase, increasing the level of demand. Since firms expect higher demand, they might invest to increase the productive potential capacity of the firm so they can keep up with the level of demand and supply an adequate amount.
Explain business expectations and confidence
If firms expect demand to increase due to a boom, the marginal propensity to invest increases and invest in capital equipment (e.g. factories) increases to maximise the rate of return. Firms invest to increase the productive potential capacity so they can keep up with the level of demand and supply an adequate amount. This shifts AD from AD1 to AD2, increasing economic growth
Define ‘ Animal Spirits’
Coined by Keynes
. Refers to business confidence; the mood of managers and firm owners about the future of the economy
. It was a feeling when making decisions about investment and it drives the level of confidence in the economy
Explain the rate of economic growth
What is the accelerator theory?
. If the economy is growing, firms will need to increase investment to have the capital equipment to produce more goods and services because of the increased demand. The firms aim to increase their productive potential capacity to maximise the amount of goods ands services sold.
. Accelerator theory is the theory that the level of capital investment is affect by changes in national income or GDP
Define accelerator theory
. Accelerator theory is the theory that the level of capital investment is affect by changes in national income or GDP
HOWEVER, there will be a time lag in the investment due to the time needed for projects such as construction of a new office. This means that investment may occur in a recession.
. The accelerator theory equation is noted down in notes
